[Pranshu and Harshal are students at National Law School of India University and Gujarat National Law University, respectively.]
In Part 1 of our analysis, we pondered upon the proposed amendments by Securities and Exchange Board of India (SEBI) to the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 2015 (PIT Regulations), outlining their objectives and potential impact on India’s insider trading framework. We discussed the rationale behind these changes, their alignment with existing regulations, and the broader implications for market participants. Building on that foundation, this part critically examines the proposal’s shortcomings and unintended consequences.
In this second part of our analysis, we critique SEBI’s proposal by dissecting its implications across three key dimensions. First, we examine how this expansion contradicts the legislative intent behind previous amendments, particularly the shift from ‘connected persons’ to ‘designated persons’ in 2018, which was intended to ensure a more focused and practical enforcement mechanism. Second, we highlight how the proposed changes erode the well-established ‘reasonable expectation’ standard, which serves as a crucial safeguard against arbitrary classifications. By disregarding this standard, SEBI risks creating a rigid framework that misclassifies legitimate market participants as insiders, ultimately stifling informed trading and market efficiency. Lastly, we analyze the inconsistencies between SEBI’s proposal and recent judicial developments, where the Supreme Court has emphasized intent and concrete evidence over broad presumptions in insider trading cases.
A Critique of SEBI’s Proposal: A Step Backward
This section critically examines SEBI’s proposed amendments to PIT Regulations, arguing that despite their “progressive” nature, they potentially create legal ambiguities and represent a regression in India’s regulatory approach to the securities market.
Contradicts the intent of previous amendments
The proposed expansion of ‘connected persons’ directly contradicts the legislative intent behind previous amendments. Initially, the code of conduct under the PIT Regulations applied to ‘employees and connected persons’. However, the TK Vishwanathan Committee in its 2018 Report on Fair Market Conduct recommended limiting applicability to ‘designated persons and immediate relatives’ rather than all connected persons, recognising the impracticality of such overly wide enforcement. The subsequent 2018 amendment incorporated this recommendation by introducing the category of ‘designated persons’ in Regulation 4. However, the current proposal to widely expand the definition of ‘connected persons’ risks undermining this carefully considered approach, potentially reverting to an impractical and overly broad regulatory scope. Casting too wide a net may lead to the inclusion of individuals who, in practice, have minimal or no access to unpublished price sensitive information (UPSI). This could create an unnecessary compliance burden and potentially dilute the focus on high-risk individuals.
Eroding the ‘reasonable expectation’ standard
The proposed changes undermine the standard for determining ‘connected persons’ under Regulation 2(1)(d). Currently, the regulation targets all persons who have or are ‘reasonably’ expected to have access to UPSI through their connection to the company or its officers, regardless of their position. The standard is based on actual access or “reasonable” expectation of access in Regulation 2(1)(d). The Supreme Court in Chintalapati Srinivas Raju v. SEBI emphasized that such reasonable expectation cannot be a mere ipse dixit and requires cogent evidence. Mere proximity (such as family relations) is insufficient to infer a reasonable expectation of UPSI access. The proposed amendments risk diluting this carefully crafted standard.
The ‘reasonable expectation’ standard aligns with the ‘mosaic theory’ of insider trading, recognised in jurisdictions like the United States. This theory posits that analysts and investors can piece together material non-public information from multiple non-material pieces of public and non-public information. The US Supreme Court in Dirks v. SEC endorsed this approach, emphasizing that the mere possession of such information does not automatically constitute insider trading. SEBI’s proposed expansion, however, seems to deviate from this nuanced understanding, potentially (mis)classifying a wide range of individuals as insiders based on their relationships rather than actual access to, or usage of UPSI. This shift could stifle legitimate market research and analysis, ultimately reducing market efficiency and price discovery mechanisms.
Moreover, the proposed changes may conflict with the emerging global trend towards a more flexible and context-specific approach to insider trading regulation. For instance, the United Kingdom’s Financial Conduct Authority has adopted a ‘person in possession’ test, which focuses on the actual possession and use of inside information rather than a person’s status or relationship to the company. Similarly, the European Union’s Market Abuse Regulation emphasises the importance of establishing a causal link between the possession of inside information and trading activity. SEBI’s proposal, by contrast, appears to be moving in the opposite direction, potentially creating a rigid framework that fails to account for the complex realities of modern financial markets and corporate structures.
Disregarding recent judicial developments
Recent Supreme Court judgments have also significantly altered the landscape of PIT Regulations in India. In Balram Garg v. SEBI, the court emphasized the importance of proving intent in insider trading cases, overturning SEBI’s decision that relied solely on circumstantial evidence. The court mandated that SEBI must provide concrete direct evidence to establish UPSI possession, rather than relying on presumptions based circumstantially on proximity or relationships. This principle was further developed in SEBI v. Abhijit Rajan. The court introduced a motive element into the definition of ‘connected persons’, holding that while “actual gain or loss is immaterial, the motive for making a gain is essential.” Thus, the court ruled that the accused were not guilty of insider trading as the intention of trading with the help of UPSI in possession was absent.
Adding to this evolving jurisprudence, the Supreme Court’s decision in Manoj Gaur v. SEBI further refined the judicial approach to insider trading cases. The court emphasised the need for a holistic assessment of the circumstances surrounding the alleged insider trading. It held that while patterns of trading and the timing of transactions are relevant factors, they cannot, in isolation, be conclusive proof of insider trading. The court stressed that SEBI must demonstrate a clear nexus between the alleged insider’s actions and the exploitation of UPSI, reinforcing the shift towards a more nuanced, intent-based approach to insider trading regulation.
These rulings signal a shift from the earlier approach under Regulation 4, which was triggered merely by proving a) trade b) while in possession of UPSI (as the Explanation to Regulation 4(1) clarifies). Together, these judgments have:
introduced ‘intent’ as the third element for ‘connected persons’, and
consequently, shifted away from a strict parity principle.
SEBI’s proposed expansion of ‘connected persons’ and inclusion of a superfluous ‘relatives’ category appears inconsistent with these judicial developments. This paper argues that this expansion contradicts the established principle that mere proximity does not create a presumption of UPSI access. Consequently, SEBI’s proposed changes could have significant legal ramifications for securities market regulation.
Conclusion: The Way Forward
The proposed amendments to insider trading regulations, although well-intentioned, raise significant concerns. They potentially conflict with established legal principles, impose excessive burdens, and might adversely impact business operations. SEBI’s expansive approach, aimed at minimizing societal costs of contra-trading by insiders, risks being counterproductive. By potentially implicating innocent parties based on mere proximity, it increases its operational costs and imposes individual burdens of rebutting charges.
This blog recommends that SEBI reconsider the proposed amendments. Rather, focus should be placed on enhancing investigative capabilities and adhering to established principles of reasonable expectation and intent, as outlined in judicial precedents. A more balanced approach, maintaining market integrity without unduly burdening individuals or businesses, would better align with the original intent of PIT Regulations and prevailing theories of insider trading and contra-trading regulation.
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